The Thick Market Effect on Local Unemployment Rate Fluctuations

Abstract

This paper develops a model to study how the thick market effect influences local unemployment rate fluctuations. The model demonstrates that the average matching quality improves as the number of workers and firms increases. Unemployed workers accumulate in a city until the local labor market reaches a critical minimum size, which leads to cyclical fluctuations in the local unemployment rate. Since larger cities attain the critical market size more frequently, they have lower unemployment rates, shorter unemployment cycles and lower peak unemployment rates. Our empirical tests are consistent with the predictions of the model. In particular, we find that an increase of two standard deviations in city size lowers the unemployment rate by 0.7 percentage points, decreases the peak unemployment rate by 0.3 percentage points, and shortens the unemployment cycles by about 0.7 months.